Apple Inc. (AAPL) And Quanta Have Bright Future Together: CLSA

Apple Inc. (NASDAQ:AAPL) has been downgraded by several analysts over the past few weeks. Others, including Pipper Jaffray’s Gene Munster have defended the stock. However, with so many sell-side analysts on vacation in the US and Europe (including Gene Munster who we did not know ever took a vacation), there has been little talk about the tech giant. In most of Asia, it is not vacation time and CLSA Asia has a new report on Apple Inc. (NASDAQ:AAPL) and Quanta Computer Inc. (TPE:2382). CLSA has some interesting points about the iMAC, which they note repeatedly, will be manufactured in the USA. We summarize the main points below:

Apple plans to make iMacs in US

Apple CEO Tim Cook said in December that Mac production in the US will be more substantial than just assembly, with plans to invest US$100m (no timeframe specified). He said, “Apple will be working with people, and will be investing our money”. The market is concerned about share loss to Hon Hai Precision Industry Co., Ltd. (TPE:2317) (better known as Foxconn), which said this month that it plans to expand its US footprint.

Quanta is already assembling iMacs in US

Quanta Computer Inc. (TPE:2382) has local configuration/assembly facilities in California and Tennessee used for Macs. In this context, Apple’s comments about moving production are nothing new. The US$100m investment quoted by Apple is not small, but is for casings/components, not assembly (which Quanta does for Apple in the US).

Apple Inc. (NASDAQ:AAPL) has been directly working with equipment suppliers for customised equipment for casings, tooling etc. Looking at Apple’s balance sheet, “long-lived assets in China” grew 180% YoY to US$7bn in September 2012 (US$2.5bn in September 2011).

Note: Long-lived assets located in China consist primarily of product tooling and manufacturing process equipment and assets related to retail stores and related infrastructure. In this context, the US$100m investment announced by Apple in December is small (1% of annual capex).

Quanta’s allocation at Apple unchanged, margins have room to rise

80%+ of iMac and MacBook. These devices are hard to manufacture. For example, the new iMac is 5mm thin at its edge, with new casing and a new display. In 2012, delays in MacBook and iMac ramp resulted in Quanta Computer Inc. (TPE:2382)’s 2012 margins being pressured (as costs related to labour were incurred, but volumes/product timelines kept slipping). With a smoother product rollout in
2013 and the Chongqing ramp behind us,CLSA believes that we are at the worst point.

Quanta’s allocation at Apple unchanged, margins have room to improve

CLSA believes that Quanta will remain the dominant source for Apple in 2013, producing 80%+ of iMacs and MacBooks. In 2012, Quanta’s volumes and margins for Apple were affected by several product delays, as these devices are hard to manufacture.

In 2012, Apple launched nine new PC models, each posing sizeable manufacturing challenges and with new components, which resulted in several delays for the whole supply chain. A case in point is the 2012 iMac launch. The new iMac is 5mm thin at the edge, with new casing and a new display, bringing a whole host of yield/manufacturing issues. This product was delayed through much of 2012, and with no new product launch, Apple’s share of the global desktop market fell to just 2.5% in 3Q12, down from 3.8% in 4Q11.

Finally, the iMac was launched in October 2012, leaving Quanta just two months to ramp the product for the holiday season. With new types of components and a new assembly process, iMac remains supply constrained, resulting in disappointing
November sales for Quanta.

Such delays put pressure on Quanta’s 2012 margins, as workforces were ready for much of the year, but volumes did not ramp as planned. Quanta leads ODMs in transfer of production inland, with 40% of production in Chongqing by end-2012, up
from less than 20% at end-2011. Ramping new production would also have incurred some teething costs (duplicate workforce, etc); another contributor to margin pressure seen in 2012.

Con conclusion

Quanta’s stock price has been under pressure in the past quarter owing to weak November sales and uncertainty over the Quanta-Apple relationship. In 4Q12, some new iMacs shipped with “Assembled in USA” stickers – from their checks, this was done by Quanta’s California facility.

In this context, Apple’s comments about moving production will not impact Quanta. Separately, they lower their 4Q12 sales forecast to 4% QoQ (previously 11% QoQ), reflecting iMac delays. CLSA Asia believes that the stock has priced in iMac constraints/MacBook weakness. With Apple-related margins set to improve and the Chongqing ramp behind us, they maintain a buy rating, albeit with a revised target price of NT$80.4 (previously NT$83.5).